Subprime Auto Loans Might Be Ok Because After All, People Need Their Cars

Late last month I asked (rhetorically) if the subprime auto bubble was bursting.

Admittedly, I haven’t followed the space closely since late 2015, but I think it’s safe to say, given the Bloomberg headlines I’ve seen over the past several months, that the same dynamics that prevailed two years ago are largely still operating today.

Remember the logic that prevailed in the lead up to the housing crash? It went something like this:

• looked at individually, these loans are sh*t
• but if you pool a bunch of sh*t, the collective becomes AAA

That didn’t work out so well.

If you drilled down into some of the subprime auto ABS deals that were getting done back in 2015, what you found was that the collateral pools were comprised of loans to borrowers that, in some cases, had no FICO scores at all. Clearly, that portends trouble.

Well, Goldman was out Monday evening with a fresh look at the numbers and in an amusing understatement, the bank calls them “less good.” Here are some fun excerpts from the note.

Via Goldman

While lending standards have tightened significantly for residential mortgages, credit standards remain relatively loose in the auto loan market. Exhibit 3 shows that the share of “subprime” loans (e.g., those with FICO<660) has remained fairly constant, now at 35%. Indeed, this significant share of loans with FICO<660 potentially understates the loosening of standards in the auto lending space, given the growth in “deep subprime” lending to borrowers with FICOs below 560 or even 500.

Despite the relatively weak lending standards in the auto loans market, delinquency rates in the sector remain lower than those for credit cards and student loans. The stronger performance of auto loans partly reflects the fact that the loans are collateralized, and also likely reflects the fact that many US borrowers prioritize auto debt in their payment sequencing.

So basically, it’s not so much that people can afford to pay for their cars, it’s that when it comes down to prioritizing, people need to drive, so they’ll do anything in their power to avoid having their mode of transportation repoed.

I’m not sure that’s a valid investment thesis.